Panama's non-bank financial sector seeks to match banking sophistication

The capital markets in Panama are highly internationalised, both in terms of capital flows and the institutions involved, with the financial stability of a dollarised economy helping attract global firms looking to expand their Latin American footprint. The country has already established itself as a regional banking hub, with 76 local and international banks operating in a country with a population of 3.86m.

However, Panama’s non-bank financial sector still has room to grow. While insurance sector assets nearly tripled in the decade to 2013, from $704.2m to $2.05bn, their share of GDP remained virtually unchanged, at 5-5.5%. Similarly, the total market capitalisation of the Panama Stock Exchange ( Bolsa de Valores de Panamá, BVP) stood at $13.44bn at end-2013, equivalent to 33.3% of GDP. This was down from 42.8% in 2005 and 36.3% in 2010, and still below the 46.7% recorded on Brazil’s BOVESPA.

Fundamentals

In accordance with Law No. 67 of 2011, the country’s financial markets are regulated by the Superintendency of the Securities Market (Superintendencia del Mercado de Valores, SMV), while the banking sector is overseen by the Superintendency of Banks of Panama and the insurance sector is governed by the Superintendency of Insurance and Reassurance. In 2015 the SMV had the second-highest budget of the three regulators, up 13% year-on-year (y-o-y) at $5.9m.

While the US Federal Reserve determines Panama’s monetary policy, due to the fact that the US dollar is used as the national currency, the state-owned universal bank, the National Bank of Panama ( Banco Nacional de Panamá, BNP), maintains responsibility for non-monetary aspects of central banking.

Legal Grounds

The key piece of legislation regulating the government’s issuance of sovereign debt is the Social and Fiscal Responsibility Law No.34 of 2008. While the law originally capped the deficit for the non-financial sector at 3.7% of GDP, the ceiling was increased to 4.1% of GDP by Law No. 25 of 2014. The law also set the maximum net debt ratio at 40% of GDP which, according to Katyuska Correa de Jiménez, director of public credit at MEF, is higher than many investors would like to see.

In Panama, net debt is calculated as the difference between gross debt and the assets of its sovereign wealth fund, the Panama Savings Fund (Fondo de Ahorro de Panamá, FAP). Importantly, the figures do not include the Panama Canal Authority, whose budget (except for the dividends it pays) is entirely separate from that of the government.

Sovereign Wealth Management

Established by Law No. 38 of 2012, the FAP was designed as a sovereign wealth fund for revenue from the Panama Canal. Its initial funding, at some $300m, came from a predecessor vehicle, known as the Fiduciary Fund for Development .

The FAP has two main objectives: to serve as a savings mechanism for the government and to provide an economic stabilisation mechanism in the event of a state of emergency or a serious economic slowdown.

The fund invests outside Panama and can hold up to 100% of its assets under management (AUM) in liquid assets; up to 70% in investment-grade sovereign or supranational bonds (or those issued by multilateral institutions), including inflation-indexed bonds; up to 30% in corporate bonds; and up to 30% in equities. Starting from the beginning of 2015, exposure to alternative investments is capped at 5%.

The FAP’s resources may not be used to guarantee government-issued securities or purchase government-backed securities, and it is prohibited from borrowing against its own assets. The fund is also banned from buying securities issued by Panamanian entities or by any entity that generates 5% or more of its total revenues in the country. However, since the start of 2015, the FAP may invest up to 5% of its AUM in Panamanian government securities purchased through the domestic secondary market. The FAP performed well in 2014, as net assets rose 4.28% to $1.29bn. Gross investment returns stood at 4.79% on lower US Treasury bond yields, as the FAP was mainly exposed to medium-term fixed-income securities. In all, the fund generated a surplus of $57.4m, compared to $1.5m in 2013. In accordance with the law, this was paid to the government to help finance the $19.57bn 2015 budget.

Strong Signals

Over the course of 2014, international observers continued to express confidence in the country. At the end of the year, the credit ratings agencies Moody’s, Standard & Poor’s and Fitch confirmed their investment-grade sovereign risk ratings of “Baa2”, “BBB” and “BBB”, respectively, with stable outlooks all around.

The three agencies highlighted the solid growth and stability of the economy, as well as the key role played by the Panama Canal in world trade. Furthermore, over the course of 2014, credit default swap prices and yield spreads over US Treasuries were consistently in line with government bonds of nearby countries with similar or better credit ratings, such as Peru, Mexico, Colombia and Brazil.

Public Debt Profile

At end-2014, Panama’s public debt totalled $18.23bn, equivalent to 41.6% of GDP. While this was up 16.2% y-o-y, the country nonetheless remains on track to achieve its public debt target of 40% of GDP or less by 2017. Furthermore, Panama was able to diversify its sources of financing, with internal debt’s share of the total decreasing by 0.7% y-o-y to 21.3%. The country’s global bonds accounted for over half of all public debt as of the end of 2014, while multilateral development loans contributed nearly 20%, trailed by Treasury notes (9.3%), Treasury bonds (8%) and commercial bank loans (5.6%). Government bank loans, Treasury bills and bilateral loans comprised most of the remaining 5%. At year-end, foreign private sector creditors held $10.53bn, or 57.8% of Panama’s total public debt, of which foreign commercial banks accounted for $1.02bn and international bonds, $9.51bn.

Taking Issue

Over the course of 2014, there were 10 auctions of Treasury bills with maturities of six, nine and 12 months for a total of $427m, and 17 auctions of Treasury notes maturing in February 2021 with a weighted average yield of 4.12%, which brought in $665.2m. Apart from $347.5m in Samurai bonds maturing in 2021 with a 1.81% coupon, all of Panama’s bonds are dollar-denominated.

In December 2014 the domestic private sector, including banks, mutual funds and pension funds, held 41.7% of the country’s $3.46bn in public debt instruments, while the public sector accounted for 58.3% – over 90% of which was held by the BNP. Importantly, secondary market trading increased by $4.7m y-o-y to reach $767.6m.

To Market to Market

Turning to the financial markets, trading on the BVP is largely focused on corporate paper, which accounted for 63% of the $5.26bn in trading in 2014. Debt instruments dominated, with $1.71bn in bonds and $685m in negotiable commercial securities. The government’s share of trading reached $1.95bn over the year, some $1.21bn of which was in Treasury notes.

There were 19 new debt issuers in 2014, accounting for 61.3% of primary market issues. Some of the largest new issues came from Fideicomiso ENA Este ($212m), Prival Finance ($200m), Hydro Caisán ($90m) and Inmobiliaria Cervelló ($84.5m).

Trading volume on the BVP in the year to May 2015 amounted to $1.55bn, with the primary market representing more than half of the total, at $863.4m, and the secondary market comprising the remaining $686m. The primary market was dominated by Treasury bills (30.3%), marketable securities (32.6%) and other corporate bonds (28.4%), whereas the secondary market was led by corporate bonds (32.5%), Treasury notes (22.5%), Treasury bonds (13.8%) and common stock (12.5%).

In terms of market performance, the benchmark BVPSI index finished at 426.11 points at the end of 2014, virtually unchanged from the 430.78 points recorded at the close of previous year.

Key Players

As of end-May 2015, there were 20 stocks listed on the exchange, with a combined market capitalisation of $13.14bn. The market remains fairly concentrated, with two companies accounting for over 70% of total market capitalisation. Grupo Financiero BG had a market capitalisation of $5.41bn, while Empresa General de Inversiones (EGI) had $3.84bn. EGI owns 100% of Empresa General de Petróleos and Empresa General de Capital, as well as 61% of Grupo Financiero BG, which is the holding company for Banco General, the largest Panamanian Bank. Another financial services holding company, Grupo Assa, is the third-largest listed firm, with a market capitalisation of $889.8m.

The market had some 25 registered members as of June 2015, many of which are subsidiaries of local banking groups, including Banco General, Banistmo and BNP. Five brokerages joined the market in 2014: BICSA Capital, Sweetwater Securities, Eurovalores, Paullier and Capital Assets Consulting. In terms of purchase volume, the largest players over the course of the year were BG Valores, Prival Securities and Citivalores, while the largest by sales volume were Prival Securities, BG Valores and MMG Bank.

Market Makers

Correa told OBG that a number of steps have already been taken in order to boost bond market liquidity and encourage greater participation by domestic investors. Following the examples of neighbouring Peru and Colombia, in 2011 the Directorate of Public Credit (Dirección de Crédito Público, DCP) established a market maker programme requiring participants to maintain a certain amount of movement in the local bond market.

Three market makers and six market maker applicants are required to simultaneously quote buy and sell prices, thereby increasing market liquidity in addition to helping to foster greater transparency of benchmark prices to develop a domestic yield curve. According to Correa, the DCP has also maintained an active investor presentation agenda to promote government bonds to overseas investors, in addition to surveying them about the kind of bonds they would be most interested in buying.

These efforts appear to have paid off. At the end of 2011, the weighted average interest rate on internal public debt stood at 3.95%, compared to 6.13% for external public debt. By the end of 2014, this interest rate spread had narrowed by some 169 basis points, to 4.75% and 5.24%, respectively. The average cost of total public debt also declined over the period, from 5.81% to 5.13%.

Latin Clear

The Central Latinoamericana de Valores (Latin Clear) has served as Panama’s central securities depository (CSD) since it began operations in May 1997. A private enterprise, Latin Clear is largely owned by brokerages and licensed banks.

In April 2014 Latin Clear established a link with Brussels-based Euroclear Bank, granting international investors more access to Panama’s capital markets. In a press release announcing the deal, Iván Díaz, CEO and general manager of Latin Clear, noted, “By utilising Euroclear’s proven infrastructure, we will be able to offer our investors and issuers access to a broad range of international counterparties while simultaneously offering investors from across the globe easy access to Panamanian government debt initially. We subsequently plan to add corporate debt and equities as well. We believe that this international link can act as a springboard for Panama, increasing scalability.” The agreement will give Euroclear and Latin Clear links to CSDs in 46 countries, including Costa Rica, Honduras, Guatemala, El Salvador, Nicaragua and Luxembourg.

Latin Clear has posted strong growth over the past several years, with its assets under custody increasing at an annual rate of 33% in the four years to April 2014, at which point its market penetration as a share of the BVP’s total capitalisation stood at around 58%. The country’s CSD has seen a number of other positive developments in recent years. In 2014 the BVP and Latin Clear moved from T+3 to T+2 settlement, and Latin Clear was granted membership in the international banking network SWIFT.

The passage of Law No. 18 of 2015 marks another step forward for Panamanian markets in terms of international transparency standards. The law amends a previous statute, Law No. 47 of 2013, which created a custody regime for bearer shares. Under the new framework, all bearer share certificates must be delivered to an authorised custodian or replaced with registered shares certificates by the end of 2015. Furthermore, issuing companies must file for authorisation with the Public Registry.

Investment Advisors

In addition to other market players, the SMV was overseeing 59 investment advisors as of May 2015. The number of actors in this segment has more than doubled since 2010 and has increased by seven-fold since 2007, when fewer than 10 such entities were registered.

The segment’s portfolio totalled $10.58bn as of the end of 2014, with the two largest players – UBS Asesores and Credit Suisse Asesoria Panamá – accounting for nearly half of this, with $3.6bn and $1.6bn, respectively. Just three other firms had portfolios in excess of $700m: Finec Asset Management, IAM Asesores and Operadora Invictus. Indeed, the segment remains fairly concentrated; the 10 largest firms accounted for $8.76bn, or 82.8% of the total.

Collectively, the country’s investment advisors were serving over 5000 clients in 2014, with around two-fifths coming from Mexico and Panama, and 800 and 600 from Colombia and Venezuela, respectively. The country breakdown by share of the portfolio was quite similar, with Mexico accounting for 27%, followed by Panama (19%), Colombia (13%) and Venezuela (11%). While the sources of capital for the segment were similarly concentrated, with five countries accounting for approximately 87% of the total of $300.3m, the rankings featured Switzerland and the US instead of Colombia.

Three classes of assets accounted for virtually all of the segment’s portfolio: cash and structured funds, with 41%; bonds, at 40%; and stocks, with 19%. Of the bonds, private issues accounted for $4.1bn, or 96.4% of the total, while government bonds made up the remaining $152.6m.

Fun with Funds

The country is also home to a small mutual funds industry. The four equity funds listed on the BVP had a total of 234 clients and AUM of $121m as of the end of March 2015, while the sole medium-term bond fund had 40 clients and $4m in AUM. Meanwhile, the five long-term bond funds had $776m in AUM and a total of 1410 clients. There are also three property funds in the market, with $250m in AUM and 1214 clients.

In terms of AUM, the largest mutual fund managers are BG Valores, Prival and MMG – all three of which are members of the Panamanian Chamber of Mutual Fund Administrators and Pension Funds (Cámara Panameña de Administradores de Sociedades de Inversión y Fondos de Pensión, CASIP).

CASIP’s membership also includes two pension fund managers: Progreso Administradora Nacional de Inversiones, Fondos de Pensiones y Cesantias, which was bought by Global Bank in September 2014, and ProFuturo Administradora de Pensiones de Fondos y Cesantias, which is a subsidiary of Banco General. The two manage voluntary occupational funds (on a defined contribution basis) for private sector workers. As of end-March 2015, Progreso had some 32,000 clients and $170m in AUM, while Pro-Futuro had around 33,000 clients and AUM of $233m.

A significantly larger pool of capital is held by Panama’s insurance companies. As of the end of 2013, their investments amounted to $1.4bn. Meanwhile, the banks in the national banking system had combined investments of $12.82bn and the international banks held $5.27bn.

Outlook

The economy appears set for stable growth with reasonably low inflation, and although there is likely to be slippage in terms of fiscal discipline, the government is expected to face little difficulty in placing securities with investors both in Panama and abroad to finance state spending.

The anticipated move by the US Federal Reserve to increase its target federal funds rate from the current range of 0-0.25% is unlikely to cause problems. Luca Ricci, the IMF’s mission chief for Panama, told OBG that bank lending rates in Panama have been fairly inelastic in response to changes in the US. Furthermore, the work undertaken by the DCP to increase liquidity in the government bond market has contributed to narrower yield spreads between Panamanian government bonds and US Treasuries of similar maturities.

Furthermore, the efforts on the part of the DCP can be seen as part of a broader set of changes that are consistent with greater transparency, efficiency and global integration of Panama’s financial markets, as evidenced by the move to T+2 settlement and the linkage between Latin Clear and Euroclear.

The recent reform to the bearer share law is also part of the official campaign to ensure Panama’s removal from the intergovernmental Financial Action Task Force’s grey list (see Banking chapter). However, Panama’s inclusion on the list has not deterred the largest Colombian banks from buying Panamanian institutions. According to data from the SMV, there is significant Colombian involvement in other parts of Panama’s financial services sector as well. So long as both economies continue their steady growth trajectories, it is reasonable to expect that these regional linkages will continue to strengthen.